Trick or Treat? A Reverse Dutch Auction of Puerto Rico’s Public Debts

This is the most novel solution to Puerto Rico’s current debt crisis we’ve studied thus far, an idea attributed to Professor Arturo Estrella, an economist at the Rensselaer Polytechnic Institute in New York State. (We say “attributed to” because we can’t find his paper anywhere on the Internet.) In summary, Prof. Estrella proposes that the Federal Reserve use its emergency lending authority under Section 13 of the Federal Reserve Act–specifically, subsection 13(3)–in order to (i) issue emergency loans to Puerto Rico’s indebted public corporations and (ii) require these public entities to buy back some or all of their massive debts through a reverse Dutch auction with their bondholders … (In an ordinary “English” or ascending-price auction, there is one seller and many buyers. The buyers submit ascending bids, and the buyer with the highest bid–the last man standing, so to speak–wins the auction. In a reverse auction, by contrast, there is one buyer and many sellers, and in a reverse “Dutch” or descending-price auction, the sellers submit descending bids and the seller with the lowest bid wins.) There are many ways of designing a reverse auction (see here, for example), but in Puerto Rico’s case, one possible “buyer” in such a reverse Dutch auction could be the debt-laden Puerto Rico Electric Power Authority or PREPA, the Island’s most indebted public corporation. In addition, the item up for auction would be the power company’s outstanding debt obligations, and the “sellers” would be the utility’s existing creditors. The beauty of this novel plan is that it would force PREPA’s creditors to compete against each other in selling back their bonds (to avoid being left out altogether) and thus make it possible for PREPA to get out of debt quickly and in an orderly fashion. We really like this plan in principle, but we would require the Commonwealth of Puerto Rico to privatize the inefficient, state-owned PREPA first, as an essential condition of receiving any emergency funding from the Federal Reserve.

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